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June 22, 2012

Morgan Deemed ‘Winner’ in Moody’s Bank-Rating Massacre

Fifteen banks’ ratings were slashed from one to three notches due to capital market risk

Fifteen banks in the U.S., the U.K. and Europe with global capital markets operations saw their ratings cut Thursday by Moody’s, some by as many as three notches, as the ratings agency continued its review of the sector. Some banks slammed the action and said investors should find analyses elsewhere.

Moody’s cut 15 banks from one to three notches, citing the risk inherent in the bank's global capital markets operations. The ratings agency had said several months ago that it would be reviewing the sector. Later, Moody's also cut a division of Lloyds TSB Bank, Reuters reported.

Morgan Stanley took a two-notch hit but saw its share price gain as much as 4.6% in extended trading because the bank had expected a three-notch downgrade. Financial services analysts with securities broker-dealer Keefe, Bruyette & Woods called the bank "a winner" compared with the other banks after the downgrade.

"Of the U.S. banks, Morgan Stanley is the clear winner as the bank received only a two notch downgrade versus the three notches that had been anticipated," KBW analysts wrote on Thursday. "JPM, C and GS all received a two notch downgrade as expected and BAC's one notch downgrade was in line with expectations as well. We believe Morgan Stanley will trade up on the news and likely outperform its peers on Friday."

After Moody’s warned of the coming action back in February, Morgan Stanley (MS) stock lost nearly 27% of its value; it also has lost dozens of financial advisors in recent months. In Friday trading, MS stock was more than 2% higher at $14.26 in midmorning versus its Thursday close of $13.96. All bank in the group were higher in a relief trade.

KBW ranked JPMorgan as a second-place winner after the ratings move, saying that although the downgrade was in line with initial expectations, investors were "moderately concerned" about the bank's $2 billion derivative trading loss and CEO Jamie Dimon's subsequent testimony before Congress.

"All of the banks affected by today's actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities," said Greg Bauer, Moody's global banking managing director, in a statement. "However, they also engage in other, often market leading business activities that are central to Moody's assessment of their credit profiles. These activities can provide important 'shock absorbers' that mitigate the potential volatility of capital markets operations, but they also present unique risks and challenges."

In addition, Lloyds TSB Bank saw its credit rating cut to A2 from A1, with a negative outlook. Moody’s cited a number of reasons for its action, including Lloyds' sensitivity to challenges in the U.K. and Europe.

Separately, Moody’s said of that action, "The current rating level and outlook incorporate a degree of expected further deterioration in the bank's operating environment and the likelihood that changes in investors' sentiment could further weaken its standalone credit profile." In its statement, Moody’s added, "Any reduction in the likelihood of systemic support for large U.K. banks could exert downwards pressure on the Lloyds' ratings."

Some of the banks struck back, criticizing Moody’s and suggesting that investors would be better served to seek data on institutions elsewhere, Bloomberg reported. Citibank in particular issued a statement that said in part, “Moody’s approach is backward-looking and fails to recognize Citi’s transformation over the past several years. Citi believes that investors and clients have become much more sophisticated in their credit analysis over the past few years, and that few rely on ratings alone—particularly from a single agency—to make their credit decisions.”

Other banks challenging Moody’s include Morgan Stanley, Bank of America and Royal Bank of Scotland. Moody’s said that those three plus Citi, which were all recipients of taxpayer bailouts, have a history of “high volatility” and problems with risk management.

Citi was not the only bank to term Moody’s action “backward-looking.” In its statement, RBS also called the ratings agency’s move “backward-looking” and added that it “does not give adequate credit for the substantial improvements the group has made to its balance sheet, funding and risk profile.” RBS dismissed the action, saying, “The impacts of this downgrade are manageable.”

That “backward-looking” assessment seems to be shared by a number of financial professionals. Ken Fisher, founder and CEO of Woodside, Calif.-based Fisher Investments, which has about $44 billion under management, was quoted in the report saying, “Moody’s is not going to detect some problem in advance and move a rating to warn the public. Whether it’s a stock or a bond, the free market already did that. Moody’s goes along afterwards and effectively validates what the market’s already done.”

The action could, however, compel firms to pay more to borrow, as well as force them to put up more collateral against derivative trades.

For its part, Morgan Stanley said the downgrade failed to account for steps it has taken to improve its financial position.

"While Moody’s revised ratings are better than its initial guidance of up to three notches, we believe the ratings still do not fully reflect the key strategic actions we have taken in recent years," said the company in a statement. "However, their acknowledgment of our long-term partnership with [Mitsubishi UFJ Financial Group] as well as our industry-leading capital and liquidity highlight some of the transformative steps we have taken. With our de-risked balance sheet, stable sources of funding, diverse business mix and strong leadership team, we are well positioned to deliver for clients and shareholders."

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